Unit 5

Property and Loans

The Good, the Bad and the Ugly of buying a home versus renting

Sydney property market and taxes

Property valuation and human bias

The process of buying a property in Sydney

Financial leverage and risk

Loan mathematics and product features

Tips to pay off your home loan faster

We will be covering …
Property Loans
The Good, the Bad and the Ugly Financial leverage
Sydney property market Loan mathematics
Property taxes Loan features
Property valuation Interest rates
Human bias and property
Home loan tips
Before you buy
Making an offer
After you buy
Property strategies
You need to be able to …
1. Identify the pros and cons of buying versus renting property
2. Explain the key drivers of property prices in the short and long-term
3. Identify key taxes associated with owning residential property
4. Explain the process of buying a residential property in Sydney
5. Apply basic valuation principles and identify human biases
6. Explain some common property strategies
7. Explain why borrowing to invest increases risk (financial leverage)
8. Calculate home loan repayments yourself
9. Explain basic loan features
10. Identify ways to pay off your home loan faster
General Advice Warning
The content of this Unit is not personal financial advice for you
It covers general principles
… taught as part of university course based on the Australian system.

It does not take into account your situation, objectives or needs.

You are responsible to consider whether it is suitable
… for your personal circumstances.

You should consider obtaining financial and tax advice yourself.

General Advice Warning
The content of this Unit is not personal financial advice for you
It covers general principles
… taught as part of university course based on the Australian system.

It does not take into account your situation, objectives or needs.

You are responsible to consider whether it is suitable

Subtitles
… for your personal circumstances. Playback Speed
Closed Captions Slower Faster

You should consider obtaining financial and tax advice yourself.

CC
The Good, the Bad and the Ugly
… about buying a home
What do I mean by a home?

House Duplex Terrace

Town House Apartment or Unit Caravan, Granny Flat, Tiny House

Retirement Village
The Good
Clint Eastwood
as ‘Blondie’
The Good … about buying a home rather than renting over the long-term

1. Control over basic needs

Provides shelter for your family and also financial and emotional security

2. Control over dwelling expenses

Especially once home loan is paid off … no rent or mortgage payments

3. Option to make improvements

Renovations to suit your needs, tastes, children and/or to improve valuation

4. Stability in lifestyle
No need to worry about a landlord asking you to leave or selling the property

5. General increase in price

Prices are expected to increase over the long-term in line with nominal income growth
The Good … about buying a home rather than renting over the long-term

6. Main residence capital gains tax exemption

Any gains in your main residence not assessable for income tax

7. Financial leverage magnifies return on equity

If the return on the asset exceeds the interest rate on debt, it magnifies return on equity

8. Cheap interest rates

Residential property is a special form of collateral. Banks are able to lend at low rates.

9. Tangible
Shares and other investments are intangible. It is nice to be able to see your asset

10. Life gives you some experience

A typical 25-year-old can better assess quality of a property than the quality of a share
The Good … about buying a home rather than renting over the long-term

11. Forces saving discipline

Principal and interest loans forces repayment of loan (saving) over 25 to 30 years

12. Low levels of market efficiency*

Opportunities to profit from uninformed or biased buyers or sellers

13. Excluded from asset tests for social security

Main residence is not included in asset tests for social security, such as the Age Pension

14. Source of funds for retirement

Downsizing your home in retirement can free up funds to invest in superannuation

∗ The concept of ‘market efficiency’ is concerned with how much current and past information is captured by the current price of an asset.
Low levels of market efficiency means that there can be opportunities to profit from uninformed people. But are you informed or uninformed?
The Bad
Lee Van Cleef
as ‘Angel Eyes’
The Bad … about buying a home rather than renting over the long-term

1. Non-divisibility
You cannot buy (or sell) 10% of a residential property. It is binary purchase (lumpy)

2. Poor liquidity
It can take months to buy or sell a property

3. High minimum investment

Entry-level properties are expensive … most people need two incomes

4. Poor diversification within property sector

Most people only have one or two properties

5. Asset-specific risk
Local factors, flooding and leaks, pests (termites), rising damp, concrete cancer, fire …
The Bad … about buying a home rather than renting over the long-term

6. Poor diversification across asset categories

Cash, fixed interest, residential and commercial property, domestic and internationals shares

7. High ‘entry fees’ when buying

Transfer duty (often 3%+), conveyancing fees, time and hassle (4%+)

8. High ‘exit fees’ when selling

Promotional videos, advertising, agent commissions and conveyancing fees (2%+)

9. Decreased flexibility
High fees and low liquidity makes it harder to move, upgrade or downgrade

10. Foregone alternatives

Investments in other assets such as a diversified portfolio of shares
The Ugly
Eli Wallach
as ‘Tuco’
The Ugly … about buying a home rather than renting over the long-term

1. Bursting of property price bubbles and recession

If property prices fall by 20%+ and you lose your job it can wipe you out

2. Dodgy property developers

Opal Tower, phoenix developers, bait-and-switch, poor construction quality …
So can I just rent my entire life and not buy?
This called the ‘Rent v Buy Debate’
Rent v Buy Debate
1. Borrow and buy home
Save $100,000
Borrow $400,000
Buy $500,000 home
Pay loan interest
Pay maintenance costs on home
Avoid paying rent for the long-term

Total wealth created over 30 years?

Rent v Buy Debate
1. Borrow and buy home 2. Rent, borrow and buy investments
Save $100,000 Save $100,000
Borrow $400,000 Borrow $400,000
Buy $500,000 home Buy $500,000 of diversified shares
Pay loan interest Pay loan interest
Pay maintenance costs on home Receive dividends on shares
Avoid paying rent for the long-term Pay rent for long-term

Total wealth created over 30 years?

2. Rent, borrow and invest over long-term
Advantages
Greater flexibility with home
Elon Musk just has no home and just rents

Tax deductions on interest

Interest on investment loan is tax deductible
Interest on home loan not tax deductible

Diversification reduces risk

Diversified share portfolio
… is better than buying a single property

Can work for Lean FIRE

Shares generate income, house does not
2. Rent, borrow and invest over long-term
Advantages Disadvantages
Greater flexibility with home Miss out on low interest rates
Elon Musk just has no home and just rents Borrowing for shares is more expensive
… than borrowing to buy property
Tax deductions on interest
Interest on investment loan is tax deductible Life-stages
Interest on home loan not tax deductible Buying home can be attractive with kids
… and very attractive when 60+
Diversification reduces risk
Diversified share portfolio Miss out on forced saving
… is better than buying a single property Home loan forces you to save

Can work for Lean FIRE Speculation

Shares generate income, house does not Risk of gambling on bitcoin!
Property and the Pie
Save for peace of mind 1 Living expense
Cash buffer, financial slack Plan to be Maintenance costs

Save to invest Generous Control in long-run

Deposit on property 2 3
Manage debt Plan for Plan to be
Pay off home loan the Future Content
Protect things you value Leverage and risk
Home and contents insurance Fixed v variable costs
Sydney Property Market
Australia
Sydney house prices
$1,400 Median house prices in $,000s Price gains = 5.9% per year
Rental yield ≈ 3.0% per year
$1,200 Total return ≈ 8.9% per year

$1,000
Sydney

$800

$600

$400 Rest of NSW

Price gains = 6.4% per year
$200 Rental yield ≈ 3.5% per year
Total return ≈ 9.9% per year
$0
2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023
Australian Bureau of Statistics (2022) ‘Total Value of Dwellings (Table 2)’ from abs.gov.au
Property Prices in the short-term
Demand Supply
Number of buyers in the market Number of sellers in the market
Perceived shortages of properties Perceived glut of properties
Fear of missing out (FOMO) Fear of not getting out (FONGO)
Property Prices in the long-term
Demand Supply
Birth rates State government land releases
Death rates Local government density rules
Migration and overseas students New home construction
Average income Availability of credit for developers
Interest rates Public transport
Live with parents culture Motorways and roads
Savings culture Technology
Mainly determined by supply-side
Be careful with house price indices
These are averages (medians)
Micro-markets within Sydney and rural areas can be quite different
The quality of the average dwelling has changed
Median house prices don’t take into account maintenance costs
Micro-markets
Prices increase at different rates in different suburbs
Determined by supply and demand factors in that area
“Gentrification” is one factor that affects demand:
When middle class move into areas that were previously
lower socio-economic in nature.
Developers buy properties and develop
Middle-class renovate their units/homes
Council spends more money in area.

If areas have large amounts of land being developed

… or large number of new apartments
… then additional supply may result in weak property prices
Be careful to avoid simply extrapolating …
Past returns are no indication of future returns!
Asset categories real and nominal returns
Asset category Real return Inflation Nominal return
1. Cash 0.5% + 2.5% = 3.0%

2. Fixed Interest 1.5% + 2.5% = 4.0%

3. Residential Property 5.0% + 2.5% = 7.5%

4. Commercial Property 6.0% + 2.5% = 8.5%

5. Australian Shares 6.0% + 2.5% = 8.5%

6. International Shares 6.0% + 2.5% = 8.5%

These are assumed long-term future expected rates of return for this course. The derivation will be discussed further in Units 9 and 10.
Asset categories price gains and income
Asset category Price gains Income Nominal return
1. Cash 0.0% + 3.0% = 3.0%

2. Fixed Interest 0.0% + 4.0% = 4.0%

3. Residential Property 5.0% + 2.5% = 7.5%

4. Commercial Property 5.0% + 3.5% = 8.5%

5. Australian Shares 5.0% + 3.5% = 8.5%

6. International Shares 6.5% + 2.0% = 8.5%

These are assumed long-term future expected rates of return for this course. The derivation will be discussed further in Units 9 and 10.
 Property Tax
New South Wales, Australia
CGT main residence exemption
Main residence is exempt from capital gains tax (gain in price)
This must be the case to avoid ‘losing money’ when moving houses
This makes it an important method for creating and ‘storing’ wealth

You are not a foreign resident

Is on land of 2 hectares or less
It has been your main residence for the entire period
Note that you are only allowed one main residence at any point in time
Has not been used to produce assessable income
Not run a business from it, rented it out or ‘flipped’ it

Australian Taxation Office (2022), ‘Your main residence’ at ato.gov.au

What about a home office?
The Australian Taxation Office (ATO) has made a distinction between …
A ‘place of business’
Running and occupancy costs may be an allowable deduction for tax purposes
CGT main residence exemption is reduced proportionally

A ‘place of convenience’
Only running costs are an allowable deduction for tax purposes
CGT main residence exemption still applies in full

Be careful about claiming tax deductions for working from home

What if I rent out a room while I live there?
Charging rent to a family member is a domestic arrangement
The rent received is not assessable for income tax
It does not affect CGT main residence exemption

Charging rent to a ‘border’ for a room in your main residence

If you are carrying on a business …
rent received is assessable income and a portion of gain in price may be subject to CGT
If you are recouping costs on a non-commercial basis …
rent received is not assessable income and gain in price may not be subject to CGT

If in doubt … check with an accountant or tax adviser

Australian Taxation Office (2022) ‘Renting out part or all of your home’ at ato.gov.au
Australian Taxation Office (1985) ‘Taxation Ruling IT2167 Income Tax: rental properties – non-economic rental, holiday home, share of residence, etc.
cases, family trust cases’ at ato.gov.au
CGT exemption for inherited dwellings
No tax is normally payable on inheritances of main residence
This must be the case to avoid a perceived ‘death tax’ on main residence
This makes it an important method of inter-generational wealth transfers

Property must be used as a main dwelling by the person inheriting the property
… or sold within 2 years of inheritance

Australian Taxation Office (2022), ‘CGT exemptions for inherited dwellings’ at ato.gov.au
The ‘6 year rule’
You can sometimes have a ‘main dwelling’ while not living in it
You can treat the dwelling as you main residence for:
1. Up to six years if it is used to produce income (usually rent)
2. Indefinitely if it not used to produce income

You cannot treat any other dwelling as main residence during the same period
It does not apply to a period before it became your main residence
It does not apply to properties owned by a company or trust
You can ‘reset’ the 6 years by moving back into it (with evidence)

Australian Taxation Office (2022), ‘Treating a dwelling as your main residence after you move out’ at ato.gov.au
NSW Stamp Duty also known as ‘transfer duty’

NSW State Government tax on transfer of ownership of property

Considering allowing people to choose between upfront stamp duty or a regular land tax

Property value Transfer duty

$0 - $15,000 $1.25 for every $100 (minimum $10)
$15,000 - $32,000 $187 plus $1.50 for every $100 over $15,000
$32,000 - $87,000 $442 plus $1.75 for every $100 over $32,000
$87,000 - $327,000 $1,405 plus $3.50 for every $100 over $87,000
$327,000 - $1,089,000 $9,805 plus $4.50 for every $100 over $327,000
$1,089,000 - $3,268,000 $44,095 plus $5.50 for every $100 over $1,089,000
$3,268,000 or above $163,940 plus $7.00 for every $100 over $3,268,000

NSW Government Revenue (2022), ‘Transfer duty’ at revenue.nsw.gov.au

Lenders Mortgage Insurance (LMI)
Not really a ‘tax’ but a fee if you borrow more than 80% of value of property
… used to ‘insure’ the banking system against a sudden collapse in property prices

Property Deposit Loan Deposit Loan LMI LMI

($) ($) ($) (%) (%) ($) (%)
1,000,000 200,000 800,000 20% 80% - -
1,000,000 150,000 850,000 15% 85% 11,305 1.13%
1,000,000 100,000 900,000 10% 90% 22,410 2.24%
1,000,000 50,000 950,000 5% 95% 43,605 4.36%

Property value here is assumed to be the total cost of buying the property including property price, transfer duty and other costs
LVR is a loan to value ratio and is calculated as Loan / Property value (including transfer duty and costs)
LMI is sometimes waived for doctors, accountants, lawyers, mining specialists, professional athletes (or entertainers) and for DHA properties.
LMI can be waived for first home buyers with 5% deposit under First Home Buyer Guarantee (FHBG)
Australian Government (2022), ‘First Home Guarantee’ at nhfic.gov.au
NSW Land Tax
A state tax payable on investment properties
Primary residence is generally exempt
It must have been your primary dwelling for the entire year
You must own the property directly (not via company or trust)

Based on assessed value of ‘land’

Which is usually less than the value of land + building

Land tax free threshold $822,000 (2022)

Starts at 1.6% + $100 of combined land value above threshold
Premium threshold of 2% cuts in at $5,026,000 (2022)

A common strategy is to hold one investment property in each state

NSW Government Revenue (2022), ‘Land tax’ at revenue.nsw.gov.au

Goods and Services Tax (GST)
Payable on newly constructed homes or apartments
It is not payable when buying an existing residential property

10% GST payable on building component (not land)

10% GST is payable on agent commissions when selling any property

… but is not payable on the rent collected from tenants on a residential property
Income tax on investment properties
Rent received is assessable income and subject to income tax
Gain on sale of property is subject to income tax (capital gains tax)
Only 50% of the gain is assessable if held for more than one year

Allowable deductions include:

Interest expenses on investment loan
Body corporate fees, council rates and water charges
Land tax
Agent fees, advertising for tenants, repairs, maintenance and cleaning
Insurance

… make sure that you use an accountant to minimise errors

Australian Taxation Office (2022), ‘Rental property expenses to claim’ at ato.gov.au

Australian Taxation Office (2022), ‘Rental expenses you can claim now’ at ato.gov.au
Property Valuation
The value of a residential property
Non-monetary benefits Garden, pool, location …

Option to make improvements Subdivide, renovations …

Present value of tax benefits Decreases required return

Present value of future rent PV of Perpetuity

Valuation approaches
1. Relative Prices
Assumes observed
2. Price-Earnings Multiple prices are ‘fair’ and
Comparables not in property asset
3. Value per square metre price bubble
4. Statistical regression
5. Present value of future rent Discounted cash flow

6. Option to make improvements Real option analysis

See my Advanced Finance channel
… but it is very very tough
1. Relative prices
Observe ask and sale prices of similar properties
Asking price is available on domain.com.au and realestate.com.au
Actual sale price is available on homepriceguide.com or by asking agent
Observe percentage difference between ask and final sale price
Observe time taken from first listing to final sale

Track asking price against actual in a spreadsheet

An underlying assumption of this method is that the observed prices are indeed ‘fair’ and there is no property asset price bubble
2. Price-Earnings Multiple
1. Observe sale price of properties sold (P)
2. Observe asking weekly rental prices for similar properties (C)
3. Estimate gross rent collected over one year (C × 50)
50 weeks assumes that 2 weeks per year will be untenanted

4. Calculate Price-Earnings multiple 𝑷𝑷

𝑷𝑷𝑷𝑷 =
𝑪𝑪 × 𝟓𝟓𝟓𝟓
5. For any new property, estimate annual gross rent (C × 50)
6. Multiply by PE for similar properties to estimate market value

An underlying assumption of this method is that the observed prices are indeed ‘fair’ and there is no property asset price bubble
3. Value per square metre
This approach works best for apartments since they have no land
1. Observe sale price of apartment sold (P)
2. Find out the number of square metres of floor space (N)
3. Calculate value per square metre (V) 𝑷𝑷
𝑽𝑽 =
𝑵𝑵
4. For similar apartment, ask agent number of square metres (N)
5. Multiply V × N to estimate market value of apartment (P)
The approach can work for houses but you need to do it for land and building separately

An underlying assumption of this method is that the observed prices are indeed ‘fair’ and there is no property asset price bubble
4. Statistical regression
The approach taken by professional property price estimation companies
Collect prices and property features for many different properties
Estimate parameters (β) for relationship between variables (X) and price (P)

𝑷𝑷𝒊𝒊 = β𝟎𝟎 + β𝟏𝟏 𝑿𝑿𝟏𝟏 + β𝟐𝟐 𝑿𝑿𝟐𝟐 + β𝟑𝟑 𝑿𝑿𝟑𝟑 + β𝟒𝟒 𝑿𝑿𝟒𝟒 + β𝟓𝟓 𝑿𝑿𝟓𝟓 + β𝟔𝟔 𝑿𝑿𝟔𝟔 + 𝜺𝜺𝒊𝒊

An underlying assumption of this method is that the observed prices are indeed ‘fair’ and there is no property asset price bubble
5. Present value of future rent in perpetuity
0 1 2 3 4 …
C1 C1(1+g)1 C1(1+g)2 C1(1+g)3 …
P
𝑪𝑪𝟏𝟏
𝑷𝑷∞,𝒈𝒈 =
𝒓𝒓 − 𝒈𝒈
‘C1’ is the annual net rent (after agent and other costs)
… growing at a rate of ‘g’ per year forever ∞
‘r’ is the required rate of return per period (based on investments with similar risk)
‘P’ is value today of the property that can generate that rent
This is the first approach that we have covered that uses valuation fundamentals and doesn’t assume current prices are ‘fair’
5. Present value of future rent example
How much would John be willing to pay for an investment property today if
he believes it will generate $20,000 per year in rent indefinitely (after
deducting agent fees and other costs), growing at 2.5% above inflation if he
can achieve a real rate of return on similar investments of 5% per annum?
𝑪𝑪𝟏𝟏
𝑷𝑷∞,𝒈𝒈 =
𝒓𝒓 − 𝒈𝒈

This is the first approach that we have covered that uses valuation fundamentals and doesn’t assume current prices are ‘fair’
5. Present value of future rent example
How much would John be willing to pay for an investment property today if
he believes it will generate $20,000 per year in rent indefinitely (after
deducting agent fees and other costs), growing at 2.5% above inflation if he
can achieve a real rate of return on similar investments of 5% per annum?
𝑪𝑪𝟏𝟏
𝑷𝑷∞,𝒈𝒈 =
𝒓𝒓 − 𝒈𝒈
𝟐𝟐𝟐𝟐, 𝟎𝟎𝟎𝟎𝟎𝟎
=
𝟎𝟎. 𝟎𝟎𝟎𝟎 − 𝟎𝟎. 𝟎𝟎𝟎𝟎𝟎𝟎

= $𝟖𝟖𝟖𝟖𝟖𝟖, 𝟎𝟎𝟎𝟎𝟎𝟎

This is the first approach that we have covered that uses valuation fundamentals and doesn’t assume current prices are ‘fair’
6. Option to make improvements
Buying the property gives you the right, but not the obligation
… to make a follow-on investment (renovation)
… that could significantly increase the value of the property

In finance, this is called a ‘real option’ and it is valuable.

This explains why houses are more valuable than apartments

There are more ‘real options’ to make improvements to land + building (in perpetuity)
… than there are to just make improvements to an apartment

Real Option Analysis is covered in my Advanced Finance channel … but it is very challenging!
Human Bias and Property
Buyers are biased by comparisons
1. Cheap property $500,000

2. Expensive property $800,000

Buyers are biased by comparisons
1. Cheap property $500,000

2. Expensive property $800,000
Buyers are biased by comparisons
1. Cheap property $500,000

2. Expensive property $800,000

3. Complete rip-off $1,000,000

Same as expensive property + something not valuable
Buyers are biased by comparisons
1. Cheap property $500,000

2. Expensive property $800,000


3. Complete rip-off $1,000,000
Same as expensive property + something not valuable
Human bias when buying
Halo effect
Attractiveness of the real-estate agent makes the house more trustworthy
Sequencing of properties from ‘rip-off’ to ‘expensive’ makes ‘expensive’ seem ‘good value’

Anchoring bias
Anchored on first price and adjust too little based on new information

Affect bias
Falling ‘in love’ with small features makes you willing to pay a premium
Visualising ‘having children’ or ‘growing old’ in the property

Endowment effect
Visiting the property in-person and touching surfaces
… makes you feel a sense of ownership that inflates perceived value
Human bias when selling
Endowment effect
You value something more highly when you own it
… and made worse by time and effort invested into renovations

Egocentric bias
Think that you have ‘good taste’ and others share your taste

Affect bias
Cherished memories and emotional attachment

Disposition effect
Reluctance to sell at a loss
Human bias and auctions
Reciprocity effect
Free coffee and ice-cream

Perceived scarcity
Opening pitch

Anchoring and adjustment bias

Suggest a high reference price

Consistency effect
Start from below reservation price to get people to keep bidding

Loss aversion
Creating the fear of missing out
Winner’s curse
Derived from ‘game theory’ for auctions in Economics
The winner in a competitive auction overpays
You paid more than the maximum value attributed to the property by everyone else

1. Be very clear about your maximum price

2. Be willing to lose
3. Avoid getting into a ‘bidding war’
4. Make an offer the week before the auction (with deadline)
5. Make an offer the week after a property is ‘passed in’
6. Consider using a professional property buyer’s agent
Property market inefficiency
There are no sophisticated ‘institutional’ investors
There are some professional buyer’s agents
Most individual buyers and sellers are relatively inexperienced
Failure to identify valuable real options to make improvements or renovations
Non-financial motives
Poor liquidity and high transaction costs
Unique and non-divisible nature of individual properties
High costs of ‘bridging finance’ for people who have bought without selling
Urgent sales from deceased estates or insolvencies

These market inefficiencies can provide opportunities

Before you buy
New South Wales, Australia
Process
1. Preliminary loan and property research (3 months)
2. Arrange pre-approval for a home loan (allow 1 month)
3. Active property search and price negotiations (3 months +)
4. Exchange of contracts (1 day)
5. Settlement (6 weeks)
6. Move in (1 day)
7. Renovations (often several in the first year or two)
Before you look …
Talk to your bank to determine how much they will lend
Determine some realistic locations and dwelling type
Likely need to go a long way SW or NW for affordability
Consider proximity to transport, work, family …
Consider starting with a two bedroom apartment (renting out the second room)

Research property prices

Domain.com.au and realestate.com.au
Apartment v houses
House Apartments
Own the land and building Own ‘air’ between the walls
Option to make major improvements Option to make minor improvements
Higher price gains over long-term Higher rental yield (rent / price)
Higher maintenance costs Lower maintenance costs
No body corporate fees Body corporate fees
Very high starting price High starting price
Torrens v Strata Title
Torrens title (houses)
The purchaser owns the land and building … forever

Strata Title (apartments)

Multiple property owners on one piece of land with shared responsibility for common areas

Leasehold title
Government owns the land and you have a lease for X years (common in other countries)

Community title
Property is shared and owned by many people with fees for common ‘community areas’

Retirement villages
Can be strata, leasehold, community or other types … get legal advice it can be shonky!

Firstmac (2018) ‘Understanding Different Types of Property Titles in Australia’ at firstmac.com.au

Consider ownership structure
1. Individual
2. Joint Tenancy
Buying the property in unity with other parties (usually a spouse)
The title automatically transfers to other owners upon your death
… bypassing your will

3. Tenancy in Common (or Tenants in Common)

Allows different owners to have a claim over specific percentage of value
The title does not automatically transfer to other owners upon your death
… and is subject to instructions in your will

4. Trust or company
A sophisticate strategy for ‘asset protection’ but may be subject to more land tax

NSW Land Registry Services (2022) ‘Tenancy – Joint or In Common’ on reg-guidelines.nswlrs.com.au

Getting the finances ready
Banks are often willing to lend up to 95% of the property value
This is generally a really bad idea
Lenders Mortgage Insurance is murder (more than 4%)

Best to only borrow 80% of the property value if possible

… I acknowledging that this can be tough for first-home buyers

Go super-lean and work hard to save a deposit of 20%

Later we will consider using a ‘Family Security Guarantee’ (use parents as guarantor)
… this will allow you to borrow up to 100% and then immediately pay off 20% of the loan
First home-owner assistance in NSW
You (or spouse) cannot have owned a home previously
You must live in it for continuous 6 months in first year

First Home Buyers Assistance Scheme (FHBAS)

Zero stamp duty on existing homes up to $650,000 with concessions up to $800,000
(saves you more than $20,000 on a $650,000 home)
First Home Owner Grant (New Homes) Scheme
Additional $10,000 toward purchase of land and home up to $800,000 in value
First Home Super Saver Scheme (FHSS)
Withdraw $50,000 on voluntary super contributions to buy home (double for couples)
First Home Buyers Guarantee (FHBG)
No Lenders Mortgage Insurance (LMI) if buying a home with only 5% deposit.
NSW Government (2022) ‘First home buyer grant and assistance’ at nsw.gov.au
Australian Taxation Office (2022), ‘First home super saver scheme’ at ato.gov.au
Australian Government (2022), ‘First Home Guarantee’ at nhfic.gov.au
Arrange pre-approval on your loan
Preferably do this before making any offers
Decide on your financial institution and specific home loan product
Make a written application involving application forms
Apply for the maximum amount possible
Provide information on your income, expenses, assets and liabilities
Provide evidence of income and regular saving

You should obtain written ‘pre-approval’

Subject to them being satisfied with the property that you buy is adequate security for loan
Usually given within a week of receiving paperwork

They rarely ‘reject’ a loan after written pre-approval is given

Property searching tips
1. Be flexible
You probably can’t afford the suburb you want

2. Use property websites

Domain.com.au and realestate.com.au

3. Take a virtual stroll down the street

Using Google Street View

4. Research actual sale prices

… or properties in the street or building using homepriceguide.com.au

5. Get to know the local agents

Be courteous and professional … and learn their names
Property searching tips
6. Rent in the area before buying
Inspecting properties is much easier and you get to know the area

7. Jog in the area and get to know the streets

Save on gym fees and get to know the local area

8. Remember that the agent is acting for the vendor (seller)

Don’t let them know that your heart is set on the property and will pay any price!

9. Estimate the ‘fair market value’

Relative price, P-E multiple, Value per square metre …

10. Be patient, avoid emotional attachment and human bias

Traditional tips on location
The golden rule is “location … location … location!”
1. Closer to the city centre the better
Although this could change with the trend to work-from-home

2. Close to transport and health services

3. Where gentrification is happening or will happen soon
4. Is aesthetically pleasing or has the potential to be so
5. Has a unique or rare positive characteristic
Scarcity strengthens your negotiating position when selling

… but everyone knows these tips!

My tips on location
Consider both supply and demand of properties
Supply is driven by new home construction
Demand is driven by people wanting to live there

Slow growth in supply and strong growth demand is good

Limited new land releases or new apartment construction

Strong growth in supply is often bad (independent of demand)

Break
5 Minutes
Making an offer
New South Wales, Australia
Before you make an offer …
Building and pest inspection
An expert looks for damage, structural problems or pest related issues
Typical cost is somewhere between $300 to $500

Strata search (for apartments)

An expert looks for problems with apartment building or management
Typical cost is somewhere between $250 and $400

You can also make a ‘contingent-offer’ on the results of the inspection

Conveyancer or solicitor
Who will handle all the ‘due diligence’ and ‘legal paperwork’?
1. Do it yourself
Not recommended as it is specialised work

2. Solicitor
Many solicitors (lawyers) handle property conveyancing as one of many matters
More expensive and may be better if an unusual situation arises
Tend to pass-on much of the work to legal secretary who does not have legal qualifications

3. Conveyancer
Property conveyancers do not have legal qualifications but only do property conveyancing
Less expensive and very experienced but may miss problems in unusual cases
Quality and capability of property conveyancers can vary significantly
A good starting point is conveyancing.com.au
Making an offer
There is an ‘art’ to negotiation
Find out the rules (eg. Low first offer, disinterest, be professional and courteous)
Practise your skills on some properties that you don’t want … but don’t be a time-waster
Remember that the ‘nice’ agent is acting on behalf of the vendor (seller)

Tell your bank and conveyancer that you are making a serious offer
They both may ask for a copy of the contract of sale (available from the real-estate agent)

Put an offer to the agent

They will pass the offer on to the vendor (seller)
There will usually be some ‘back and forth’ as they ask for more
… or wait for a better offer from someone else
Exchanging contacts
In Australia, a verbal acceptance of an offer is worthless
The vendor can still ‘shop around’ and contact other buyers asking for a higher offer
If another buyer offers them more … consider yourself ‘gazumped’

1. Make sure your conveyancer or solicitor has reviewed contract of sale

2. Arrange for 10% deposit
3. Go to the real-estate agent immediately with signed contact of sale
4. Exchange contracts and pay the deposit
0.25% of purchase price penalty if withdraw within the 5-day cooling-off period
Vendor may ask for a Section 66W Certificate to waive your 5-day cooling-off period

Department of Fair Trading (2022), ‘Contract and deposits’ at fairtrading.nsw.gov.au

After exchanging contracts …
You have 6 weeks (42 days) until settlement and the clock is ticking …
Settlement is when the remaining 90% of funds will need to be paid

Tell your bank that you have exchanged contracts

Sign all necessary home loan documentation
Best to get legal advice about home loan contract before signing it

Solicitor or conveyancer does all the other ‘conveyancing’ work

Best to ‘follow them up’ to make sure everything is going smoothly

Book furniture removalists, friends and family

Furniture removalists often need to be booked about 6 weeks in advance

Arrange house insurance, electricity, water and broadband connection

The bank will require evidence that you have insurance
Settlement
Settlement involves the final 90% payment and transfer of title
Standard is exactly 6 weeks (42 says) after exchanging contracts
Some vendors may accept a delayed settlement period

Do a final inspection on the morning of settlement day

Visit the property and make sure it hasn’t been damaged by tenants (or burnt down)

You do not attend the settlement

Settlement is done electronically between banks and solicitors or conveyancer for each party
They check that paperwork, transfer of title and finances are all in order

If successful, your solicitor or conveyancer will notify you

… if not successful, they will notify you of the reason for failure and the new date

Department of Fair Trading (2022), ‘Contract and deposits’ at fairtrading.nsw.gov.au

After settlement
Contact electricity, water and broadband to confirm connection
Pick up the keys from the real-estate agent
Move in
Notify others of change of address
Driver’s licence with Roads & Maritime Services
Australian Electoral Commission
Employer
Financial institutions (bank, super funds, investments)

Throw a house-warming party with friends!

After You Buy
On-going ownership costs
Council rates
Water and sewerage service
Maintenance costs
Body corporate and strata management fees (apartments)
Renovating
Most people invest too much in renovations
If price goes up … how much is from renovations?
Avoid being the best house in the street
Maintenance important to keep the value
Pest inspections, guttering, external painting etc.

Avoid spending more than 10% of purchase price

Renovating is expensive and may not add as much value as you think
Watch out for the renovation hype
Renovating an old two bedroom apartment
1. Learn to paint
Use good quality paint and special paint for bathrooms

2. Kitchen
Replace kitchen cupboard doors, taps (quality), cooktop and oven
3. Bathroom
Re-grout tiles (professional), replace mirror, cabinet doors and taps
4. Lights
Replace old light fixtures and but lots of modern lamps
5. Flooring
Replace carpet or polish floorboards
6. Technology
Invest in high quality wireless router and repeaters. Add Alexa or Google Home
Renovations that may not add value
Expensive professional landscaping
Unusual colour schemes
Renovations that do not have council approval
Pool
Selling … and then buying another property
The timing of selling a property then buying another is difficult
Uncertain time to find property to buy
+ uncertain time to sell current property

Sometimes ‘emotional’ people buy before they sell old property

This is usually a big mistake
Bridging finance is expensive and difficult to obtain
An alternative strategy for moving house …
1. Decide where you would like to live next
2. Rent a home in the new location
3. Rent out your old home then put it on the market for sale
4. Wait until your old home is sold
5. Search and buy your new home at leisure
Property and divorce
Divorce can be emotionally and financially devastating
Marriage and de facto relationships are normally treated the same

The default situation is that assets are split evenly

This can depend on whether you signed a Binding Financial Agreement (prenup)
Family Court will favour the parent who is primary carer for children

1. Make sure you have been together for 5 years before buying together
2. Men should expect zero equity upon family break-down
The main residence is usually awarded to the mother (if there are dependent children)
The father is still expected to support the children financially
… but now has to pay rent to live somewhere else
This is a generally a good system because it protects the vulnerable
20 Property Strategies
1. Buy and Hold
Buy investment property and hold it for the very long-term (20+ years)
Never pay tax on capital gains because you don’t sell it
Use equity from property to buy other investment properties or shares
Gradually moves from negative to positive cash flow
Repayments remain roughly the same over time
Rent gradually increases in line with nominal average incomes (including inflation)
2. CGT Main Residence Exemption
Main residence is one of the few assets
… with non-assessable gains for income tax
Make good use of it!
For couples with two properties
... each individual can have different declared ‘main residence’
3. Negative Gearing
1. Buy investment property
2. Take out maximum investment loan possible as interest-only loan
3. Make sure your investment property reduces taxable income
Assessable income: Rent
Allowable deductions: Investment loan interest, agent fees, maintenance ….
Taxable income = Assessable income less allowable deduction

4. Offset ‘loss’ against salary income to reduce income tax

5. Hold property for long-term to achieve gain in asset value
4. Positive Cash Flow
1. Build up portfolio of investment properties
2. Focus on properties that generate good rental income
These may be lower valued properties in areas of high rental demand

3. Make sure portfolio generates positive cash flow

Cash inflow: Rent
Cash outflows: Investment loan interest, agent fees, maintenance ….

4. Stop working and enjoy ‘passive income’ (financial independence)

5. Lean Boomerang
1. Move out of home … enjoy some independence and save nothing!
2. Move back into home with parents
3. Extreme saving (70% of income) … to save deposit on home
6. Investor Boomerang
1. Buy two bedroom apartment and live in it for 6 months
2. Move back home with parents
3. Rent out two bedroom apartment as investment property
4. Keep 2 bedroom apartment as your ‘main residence’
Use 6 year rule to maintain CGT main residence exemption
7. Trend-setter
The trendy inner-city suburbs are all completely unaffordable
‘Walk your own path’ further out in NW, W and SW Sydney
8. Buy New or Off-The-Plan
Not recommended
There can be significant time delays for construction completion
The market may have ‘turned’ in by the time property is completed
There have been a lot of problems with phoenix developers
… and poor quality construction
There is often a ‘premium’ paid on new homes

Buy apartments that are 20+ years old because problems have surfaced
9. Distressed Sales
Deceased estates
Insolvencies
People who have bought new property but cannot sell old one

Offer distressed sellers a quick transaction and settlement

These are ‘vulture’ acquisitions
10. Renovate to Hold
1. Buy undervalued property that needs renovation
2. Renovate them yourself
3. Rent out the property
Some couples ‘tag-team’ their CGT main residence

It is very easy for renovations to go over budget

You need to make renovations that will attract good tenants
… and not overcapitalise
11. Renovate to Flip
1. Buy undervalued property that needs renovation
2. Renovate them yourself
3. Sell property for a profit for ‘tax-free income’
Usually people claim CGT main residence exemption so don’t include gain in tax return
Some couples ‘tag-team’ their main residence so you don’t have to live in construction zone!

ATO has made it clear that gain from flipping is assessable income
Works best in a ‘hot’ property market
How much of the gain is from the renovation and how much from general price increase?

Possibly an effective strategy for young tradespeople

Interest on home loan and stamp duty can really cut your margins

Sean Callery (2018), ‘House Flipping in Australia – Easy Profit or Overhyped Fantasy?’ at canstar.com.au
12. Granny Flat
Buy a house with a larger block of land (usually above 500m2)
Build a small ‘granny flat’ on a property for under $80,000
If it complies with the law, council approval may not be necessary
Rent it out for more than $200+ per week
This is a gross rental yield of $200 × 50 weeks / $80,000 = 12.5%

State Environment Planning Policy (Affordable Rental Housing) 2009

NSW Government (2022) ‘Complying Development: Granny Flats’ at planningportal.nsw.gov.au
13. Dual Occupancy
Don’t just build a granny flat … build an entire second dwelling
Earn a second income to help pay your mortgage payments
… but tends to be a lower rental yield than the ‘granny flat’ option
Requires council approval
Council rates will also increase
14. Springboard
Don’t buy your dream-home as your first home
It will take ages to save the deposit and you will have a huge home loan

1. Buy a two bedroom apartment that is at least 30 years old

The quality of newly constructed apartments is highly questionable
… there are a lot of shonky operators and ‘phoenix’ developers
Most problems with an apartment building have surfaced after 30 years
There are also opportunities to do some internal renovation yourself ‘on the cheap’

2. Rent out the second bedroom to a border

3. Aggressively pay down the home loan and wait for price increase
4. Buy dream-home while retaining apartment as investment property
15. Tag-Team
For stable couples who have made life-long commitments …
1. Buy Property A under name of Person 1 (highest income)
2. Later … buy Property B under name of Person 2 (lowest income)
Rent out Property A property as investment property
Borrow maximum investment loan against Property A
Person 1 claims interest as tax deduction
Person 1 declares Property A to be ‘main residence’ and use 6-year rule for CGT relief

3. Focus on paying off home loan for Property B

Property B is main residence for Person 2.
Interest on home loan is not tax deductible so pay it off as soon as possible
16. Full-House
If you are life-long friends with another couple with no kids
1. Buy one small house owned by four adults
Purchase as ‘tenants in common’ with specific ownership percentages
Use a solicitor to draft an agreement to cover contingencies
Each couple has separate home loan (preferably with the same bank)
Save on living costs shared amongst four adults

2. Aggressively pay down home loan with four incomes for X years
3. After X years both leave and retain as investment property
Both couples borrow against equity to buy their next property
17. Inter-State Roll-Up
1. Buy first property in Sydney
Aggressively pay down home loan and wait for increase in price

2. Buy second property in Melbourne

Borrow using equity from first property and second property as collateral on loan

3. Buy third property in Brisbane

Borrowing using equity from first two properties and third property as collateral

4. Buy fourth property in Perth

Borrowing using equity from first three properties and fourth property as collateral

5. …
Buying properties in different states helps to avoid paying land tax
Is sometimes done in ‘trust’ structure but this can have implications for land tax in NSW
18. Subdivision
Buy a property with a large land size (usually above 1,000m2)
Wait for local council to change subdivision rules
Sub-divide property into two then:
1. Sell off 500m2 parcel of land; OR
2. Build a house and sell land and house
19. Downsizing
After age 65 …
1. Kick out any remaining adult kids (boomerangs)
2. Sell the 4 bedroom family home that you have owned for 10+ years
3. Buy a smaller 2 to 3 bedroom home or 2 bedroom apartment
4. Invest $300,000 each into superannuation
Note that the Downsizing Contribution into super can be done as early as age 60
20. Commercial Property
Shops, small offices or warehouses
Stable tenants over many years (reduces risk)
Higher rental yield than residential property
Diversification away from residential property reduces some risk
… but what if businesses leave the area (increases risk)
… and minimum entry price can be a lot higher than residential property
Remember … The Bad
1. Non-divisibility
You cannot buy (or sell) 10% of a residential property. It is binary purchase (lumpy)

2. Poor liquidity
It can take months to buy or sell a property

3. High minimum investment

Entry-level properties are expensive … most people need two incomes

4. Poor diversification within property sector

Most people only have one or two properties

5. Asset-specific risk
Local factors, flooding and leaks, pests (termites), rising damp, concrete cancer, fire …
Remember … The Bad
6. Poor diversification across asset categories
Cash, fixed interest, residential and commercial property, domestic and internationals shares

7. High ‘entry fees’ when buying

Transfer duty (often 3%+), conveyancing fees, time and hassle (4%+)

8. High ‘exit fees’ when selling

Promotional videos, advertising, agent commissions and conveyancing fees (2%+)

9. Decreased flexibility
High fees and low liquidity makes it harder to move, upgrade or downgrade

10. Foregone alternatives

Investments in other assets such as a diversified portfolio of shares
… and the Ugly
1. Bursting of property price bubbles and recession
If property prices fall by 20%+ and you lose your job it can wipe you out

2. Dodgy property developers

Opal Tower, phoenix developers, bait-and-switch, poor construction quality …

3. Home affordability for new home buyers

Too many people buying investment properties contributes to home affordability problems
Financial Leverage
Archimedes
“Give me a lever long enough
and a fulcrum on which to place it
and I shall move the world!”

Famous mathematician and inventor

in ancient Greece (3rd century B.C.)
Operating Leverage and Risk Visualised
Fixed Fred Flexible Fiona
Expenses, Income ($,000s) Expenses, Income ($,000s)
100 100
HIGH operating leverage LOW operating leverage
HIGH profit risk LOW profit risk
75 75

50 50
Break-even Break-even

25 25

0 0
0 25 50 75 100 0 25 50 75 100
Income ($,000s) Income ($,000s)
Operating Leverage and Risk Calculations
Fixed Fred Flexible Fiona
Expenses = 40,000 + 0.2 × Income Expenses = 10,000 + 0.8 × Income
Profit = 0.8 × Income – 40,000 Profit = 0.2 × Income – 10,000

Income
$0 $50,000 $100,000
Fixed Fred’s Profit – 40,000 0 + 40,000 High Operating Leverage
$80,000 variation

Flexible Fiona’s Profit – 10,000 0 + 10,000 Low Operating Leverage

$20,000 variation

Risk is variation
Two types of leverage
1. Operating leverage
High fixed expenses in proportion to total expenses increases risk

2. Financial leverage
High fixed interest expenses in proportion to total expenses increases profit risk (income leverage)
High levels of debt in proportion to total assets increases equity risk (capital leverage)
Example of leverage using property
Two investors would like to buy a property for $1,000:
Ursa has $1,000 cash and will not borrow anything (unlevered)
Liam has $500 cash and will borrow $500 at 5% per annum (levered)
Assume no taxes or transaction costs
Each investor plans to buy the property then flip (sell) it in 1 year.
Example of leverage using property
Two investors would like to buy a property for $1,000:
Ursa has $1,000 cash and will not borrow anything (unlevered)
Liam has $500 cash and will borrow $500 at 5% per annum (levered)
Assume no taxes or transaction costs
Each investor plans to buy the property then flip (sell) it in 1 year.

What is return on equity for the following scenarios:

1. Total return on the asset (property) is 0%?
2. Total return on the asset (property) is 10%?
Balance sheets
URSA
Assets (A) 1,000 Debt (D) 0

Equity (E) 1,000

Value (V) 1,000 Value (V) 1,000

𝑫𝑫
𝑳𝑳𝑳𝑳𝑳𝑳 = Unlevered
𝑽𝑽
𝟎𝟎
= = 𝟎𝟎
𝟏𝟏, 𝟎𝟎𝟎𝟎𝟎𝟎

LVR is ‘Loan to value ration’ which is the total loan (debt) divided by the total value of the asset (A) or (V)
Balance sheets
URSA LIAM
Assets (A) 1,000 Debt (D) 0 Assets (A) 1,000 Debt (D) 500

Equity (E) 1,000 Equity (E) 500

Value (V) 1,000 Value (V) 1,000 Value (V) 1,000 Value (V) 1,000

𝑫𝑫 𝑫𝑫
𝑳𝑳𝑳𝑳𝑳𝑳 = Unlevered 𝑳𝑳𝑳𝑳𝑳𝑳 = Levered
𝑽𝑽 𝑽𝑽
𝟎𝟎 𝟓𝟓𝟓𝟓𝟓𝟓
= = 𝟎𝟎 = = 𝟎𝟎. 𝟓𝟓
𝟏𝟏, 𝟎𝟎𝟎𝟎𝟎𝟎 𝟏𝟏, 𝟎𝟎𝟎𝟎𝟎𝟎

LVR is ‘Loan to value ration’ which is the total loan (debt) divided by the total value of the asset (A) or (V)
Ursa’s return on equity (unlevered)
Return on asset rA = 0%
Buy property at t = 0 –1,000
Sell property at t = 1 +1,000
Profit 0
Equity invested 1,000
Return on equity (profit / equity) rE = 0%
Ursa’s return on equity (unlevered)
Return on asset rA = 0% rA = 10%
Buy property at t = 0 –1,000 –1,000
Sell property at t = 1 +1,000 +1,100
Profit 0 +100
Equity invested 1,000 1,000
Return on equity (profit / equity) rE = 0% rE = +10%
Liam’s return on equity (levered)
Return on asset rA = 0%
Buy property at t = 0 –1,000
Sell property at t = 1 +1,000
Pay 5% interest on loan –25
Profit –25
Equity invested 500
Return on equity (profit / equity) rE = –5%
Liam’s return on equity (levered)
Return on asset rA = 0% rA = 10%
Buy property at t = 0 –1,000 –1,000
Sell property at t = 1 +1,000 +1,100
Pay 5% interest on loan –25 –25
Profit –25 +75
Equity invested 500 500
Return on equity (profit / equity) rE = –5% rE = +15%
Financial leverage increases risk
Return on asset rA = 0% rA = 10%
Ursa’s return on equity rE = 0% rE = +10%
Liam’s return on equity rE = –5% rE = +15%

Return on asset
0% 5% 10%
Liam return on equity – 5% 5% + 15% High Financial Leverage
20% variation

Ursa return on equity – 0% 5% + 10% Low Financial Leverage

10% variation

Risk is variation
Financial leverage
Involves borrowing money to buy an investment
It magnifies the possible outcomes
… which also magnifies risk

If the return on the asset exceeds the cost of debt

… then financial leverage magnifies profits (return on equity)

If the return on asset is less than the cost of debt

… then financial leverage magnifies losses (return on equity)
Financial leverage is key to wealth creation
The expected return on a quality property investment
… is expected to exceed interest rates over the long-term (20+ years)

Financial leverage significantly magnifies

… the return on each dollar of your own funds invested (equity)

Financial leverage is a key strategy for creating wealth over the long-term
… but it does so with a higher level of risk
When financial leverage goes wrong …
Failure to repay debt can cause bankruptcy
Close to half of the bankruptcies involves loans less than $15k

Declaring bankruptcy goes onto the public record

… and comes with professional and lifestyle restrictions

Alternatives to bankruptcy include:

Informal arrangement with the lender
Bankruptcy Act Part IX debt agreement
Bankruptcy Act Part X arrangement
Loan Mathematics
What is an annuity? (recap)
0 1 2 3 4 5
C C C C C

An annuity is a set of regular cash flows

For an ‘ordinary’ annuity
… the first cash flow occurs at the end of the first period
… and the cash flows are always level (not growing)
Present value of an annuity (recap)
0 1 2 3 4 5
C C C C C
P
We are calculating the value of the cash flows (with first cash flow at end of first period)
… at the START of the regular series of payments

Here the regular cash flow is ‘C’

there are 5 cash flows and we are moving them to t = 0
to calculate the present value of the annuity ‘P’
Present value of an annuity formula (recap)
0 1 2 3 4 5
C C C C C
P
−𝒏𝒏
𝟏𝟏 − 𝟏𝟏 + 𝒓𝒓
𝑷𝑷𝒏𝒏 = 𝑪𝑪 ×
𝒓𝒓
‘C’ are the regular cash flows that are being moved to the left
‘n’ is the number of cash flows (with first cash flow at end of first period)
‘r’ is the effective rate of return per period (time value of money)
‘P’ is value of the regular series of ‘n’ cash flows of ‘C’ at the start (left)
Borrowing capacity example
0 1 2 3 4 5
10 10 10 10 10
P
−𝒏𝒏
𝟏𝟏 − 𝟏𝟏 + 𝒓𝒓
𝑷𝑷𝒏𝒏 = 𝑪𝑪 ×
𝒓𝒓
How much we borrow if we can pay $10 p.a. for 5 years at 5% p.a.?

* By default you should assume that the cash flows occur at the end of each period (unless otherwise specified)
Borrowing capacity example
0 1 2 3 4 5
10 10 10 10 10
P
−𝒏𝒏
𝟏𝟏 − 𝟏𝟏 + 𝒓𝒓
𝑷𝑷𝒏𝒏 = 𝑪𝑪 ×
𝒓𝒓
How much we borrow if we can pay $10 p.a. for 5 years at 5% p.a.?
𝟏𝟏 − 𝟏𝟏. 𝟎𝟎𝟎𝟎−𝟓𝟓 Calculator
𝑷𝑷𝒏𝒏 = 𝟏𝟏𝟏𝟏 × 𝟏𝟏𝟏𝟏 × 𝟏𝟏 − 𝟏𝟏. 𝟎𝟎𝟎𝟎 𝒙𝒙∎ − 𝟓𝟓 → ÷ 𝟎𝟎. 𝟎𝟎𝟎𝟎 =
𝟎𝟎. 𝟎𝟎𝟎𝟎
Spreadsheet
= $𝟒𝟒𝟒𝟒. 𝟐𝟐𝟐𝟐 = 𝟏𝟏𝟏𝟏 ∗ ( 𝟏𝟏 − 𝟏𝟏. 𝟎𝟎𝟎𝟎 ^ − 𝟓𝟓 )/ 𝟎𝟎. 𝟎𝟎𝟎𝟎
* By default you should assume that the cash flows occur at the end of each period (unless otherwise specified)
Loan repayment example
0 1 2 3 4 5
C C C C C
$43.29
−𝒏𝒏
𝟏𝟏 − 𝟏𝟏 + 𝒓𝒓
𝑪𝑪 = 𝑷𝑷𝒏𝒏 ÷
𝒓𝒓
We borrow $43.29 now. Yearly payments for 5 years at 5% p.a.?

* By default you should assume that the cash flows occur at the end of each period (unless otherwise specified)
Loan repayment example
0 1 2 3 4 5
C C C C C
$43.29
−𝒏𝒏
𝟏𝟏 − 𝟏𝟏 + 𝒓𝒓
𝑪𝑪 = 𝑷𝑷𝒏𝒏 ÷
𝒓𝒓
We borrow $43.29 now. Yearly payments for 5 years at 5% p.a.?
Calculator
𝟏𝟏 − 𝟏𝟏. 𝟎𝟎𝟎𝟎−𝟓𝟓 𝟒𝟒𝟒𝟒. 𝟐𝟐𝟐𝟐 ÷ ( 𝟏𝟏 − 𝟏𝟏. 𝟎𝟎𝟎𝟎 𝒙𝒙∎ − 𝟓𝟓 → ÷ 𝟎𝟎. 𝟎𝟎𝟎𝟎 ) =
𝑪𝑪 = 𝟒𝟒𝟒𝟒. 𝟐𝟐𝟐𝟐 ÷
𝟎𝟎. 𝟎𝟎𝟎𝟎 Spreadsheet
= $𝟏𝟏𝟏𝟏. 𝟎𝟎𝟎𝟎 = 𝟒𝟒𝟒𝟒. 𝟐𝟐𝟐𝟐 / ( ( 𝟏𝟏 − 𝟏𝟏. 𝟎𝟎𝟎𝟎 ^ − 𝟓𝟓 )/ 𝟎𝟎. 𝟎𝟎𝟎𝟎 )
* By default you should assume that the cash flows occur at the end of each period (unless otherwise specified)
How much can David borrow?
David is able to afford monthly loan repayments of $1,000 per month. He is
considering taking a home loan with a loan term of 25 years (300 months) at
an interest rate of 6% per year compounded monthly (0.5% per month). The
first loan repayment would be in one month. How much can he borrow?
−𝒏𝒏
𝟏𝟏 − 𝟏𝟏 + 𝒓𝒓
𝑷𝑷𝒏𝒏 = 𝑪𝑪 ×
𝒓𝒓
How much can David borrow?
David is able to afford monthly loan repayments of $1,000 per month. He is
considering taking a home loan with a loan term of 25 years (300 months) at
an interest rate of 6% per year compounded monthly (0.5% per month). The
first loan repayment would be in one month. How much can he borrow?
−𝒏𝒏
𝟏𝟏 − 𝟏𝟏 + 𝒓𝒓
𝑷𝑷𝒏𝒏 = 𝑪𝑪 ×
𝒓𝒓
𝟏𝟏 − 𝟏𝟏. 𝟎𝟎𝟎𝟎𝟎𝟎−𝟑𝟑𝟑𝟑𝟑𝟑
= 𝟏𝟏, 𝟎𝟎𝟎𝟎𝟎𝟎 ×
𝟎𝟎. 𝟎𝟎𝟎𝟎𝟎𝟎

= $𝟏𝟏𝟏𝟏𝟏𝟏, 𝟐𝟐𝟐𝟐𝟐𝟐
What will be Fiona’s loan repayments?
Fiona would like to borrow $400,000 to buy a new home. She is considering
a loan term of 30 years (360 months) at an interest rate of 6% per year
compounded monthly (0.5% per month). The first loan repayment would be
in 1 month. What will be her monthly loan repayments?
−𝒏𝒏
𝟏𝟏 − 𝟏𝟏 + 𝒓𝒓
𝑪𝑪 = 𝑷𝑷𝒏𝒏 ÷
𝒓𝒓
What will be Fiona’s loan repayments?
Fiona would like to borrow $400,000 to buy a new home. She is considering
a loan term of 30 years (360 months) at an interest rate of 6% per year
compounded monthly (0.5% per month). The first loan repayment would be
in 1 month. What will be her monthly loan repayments?
−𝒏𝒏
𝟏𝟏 − 𝟏𝟏 + 𝒓𝒓
𝑪𝑪 = 𝑷𝑷𝒏𝒏 ÷
𝒓𝒓
𝟏𝟏 − 𝟏𝟏. 𝟎𝟎𝟎𝟎𝟎𝟎−𝟑𝟑𝟑𝟑𝟑𝟑
= 𝟒𝟒𝟒𝟒𝟒𝟒, 𝟎𝟎𝟎𝟎𝟎𝟎 ÷
𝟎𝟎. 𝟎𝟎𝟎𝟎𝟎𝟎

= $𝟐𝟐, 𝟑𝟑𝟑𝟑𝟑𝟑
Interest Rates
Interest Rates driven by Monetary Policy
Reserve Bank of Australia (RBA) influences interest rates
Monetary policy involves:
1. Setting the ‘cash rate’ which directly influences all interest rates
2. Buying and selling government bonds to influence liquidity
The goal of this is to influence aggregate expenditure in the economy
Higher interest rates decrease consumption and investment
Lower interest rates can stimulate consumption and investment

The level of aggregate expenditure influences inflation

RBA target for inflation is between 2% – 3% p.a.
Cash rate affects all other interest rates

Source: Reserve Bank of Australia (RBA)

Interest rate components
Risk Risk of the borrowers failing to make repayments

Power of financial institutions over

Market Power
borrowers and lenders (competitive rivalry)

Demand and supply of loanable funds

Loanable Funds

Central bank normally sets nominal cash rate

Real Cash Rate
above expected inflation
Inflation Reward for lending should exceed inflation
How do banks determine fixed interest rates?
Fixed interest rate = average expected variable rate + liquidity premium
Expected variable rates are 3% in 1st year, 4% in 2nd year and
5% in 3rd year and 0.5% liquidity premium. What is 3 year fixed interest rate?

0 1 2 3
3% 4% 5%
Calculate average* Then add liquidity premium
i1 + i2 + i3
i = i f 4% + 0.5%
=
3
= 4.5%
3% + 4% + 5%
= 4%
3
∗ A geometric average is normally used but I’ve used an arithmetic average here for simplicity!
Term structure of interest rates and yield curves
Fixed interest rate = average expected variable rate + liquidity premium

Variable interest rates expected to remain the same or increase

Fixed interest rate

Variable interest rates expected to fall slightly

Variable interest rates expected to fall significantly

Fixed interest rate period (years)

In bond markets, this is called a ‘yield curve’ and shows the relationship between the maturity of a bond and the yield to maturity of the bond
Fixed interest rates for different fixed periods are determined by bond market yields.
Interest rate matrix
Interest only attracts a premium over principal and interest loans
Investment loans attract a premium over home loans

Principal + Interest Interest Only

Home Loan 4.39% 4.94% +0.55%

Investment Loan 4.99% +0.60% 5.24% +0.85%

Comparison rates
Interest rate = Interest cost per year
Comparison rate = Interest + up-front and ongoing fees per year
Calculated based on $150,000 loan over a 25-year loan term

Interest Rate Comparison Rate

Home Loan 4.39% 4.49% +0.10%

Loan Features
3 types of lenders
1. Major retails banks
ANZ (ING Direct), Westpac, St George, CBA, NAB (UBank)
Good service and good features
Consistent, moderate interest rates

2. Smaller banks and lenders

Adelaide Bank, Bendigo Bank, Bank of Queensland
Can offer low interest rates to make sales … but then increase the rate once you are in

3. Mortgage brokers and other non-bank financial inst.

Aussie Home Loans, Mortgage Choice
Help you to find the cheapest home loan
2 repayment options
1. Payments consist of both principal and interest
Each loan payment is part principal and interest (mostly interest towards start of loan)
Loan is fully paid off at the end of the term (eg 25 years)

2. Interest only payments

Only pay interest on principal for first X years (10 years max)
Reverts to principal and interest loan after X years
Popular with owners of investment properties who want to maximise tax deductible interest
3 interest rate options
1. Variable interest rates
Monthly repayments change as variable interest rates change
Expect average variable rate is less than fixed rate over long-run (liquidity premium)

2. Fixed interest rates

Calculated as average of expected future variable rates plus liquidity premium
Maximum fixed rate period offered by banks is usually 10 years
Can be charged a large penalty fee if re-finance loan within fixed period

3. Split rates
Part variable and part fixed … people use them to ‘hedge their bets’
Attractive if you want a fixed rate but also some the flexibility of variable products (redraw)
Repayment terms
Period over which loan must be repaid
Maximum is usually 30 years
Shorter the term
Higher the compulsory repayments
The lower the total interest in the long-run
Less likely to be able to make voluntary extra repayments
Choose if you need the bank to force you to make high payments

Longer the term

Lower the compulsory repayments but higher interest
Choose if you are a good saver and will make extra repayments
Mortgage offsets and redraw facilities
Mortgage offset account
Balance of your savings account reduces principal outstanding
If average balance is $10,000 then …
… bank calculates interest on loan outstanding - $10,000
Allows you to pay off loan faster with same repayments
Very good feature if it doesn’t cost you a higher interest rate!

Redraw facility
Allows you to withdraw extra repayments at any time

Normally only available with variable rate loans

Some fixed interest loans offer limited redraw or offset facilities
Family Security Guarantee
A family member adds their own property as security on your loan
Total assets as collateral often doubles
Bank may be willing to lend 100% of value of the property
No Lenders Mortgage Insurance (LMI) since LVR is under 80%

Your parent’s property is at risk if you default

… but this is unlikely if you saved 20% deposit
… and place the entire deposit on ‘redraw’ on day 1
Reverse Mortgage
Allows people aged 60 or above to borrow against their home equity
… and make no loan repayments for the rest of their life
When property is eventually sold
… bank claims the ‘principal and interest’
… out of the proceeds of the sale
There is usually very little left for children or grandchildren

May be useful if you have no children (or hate them!)

Home Loan Tips
1. Pay more than the minimum required
This is usually only an option if you have a variable or split loan
Any additional payment are available in redraw and can still be accessed
 Accelerated loan repayments
The way out of slavery!
$300,000

$250,000

$200,000

$150,000

$100,000

$50,000

$0
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25
2. Avoid borrowing ‘to capacity’
3. Avoid paying Lenders Mortgage Insurance
Borrow less than 80% or use a Family Security Guarantee
4. Use Family Security Guarantee if possible
Borrow 100% of value of property
Place your 20% deposit on ‘redraw’
You still have access to these funds
… for emergency or to make other investments
5. Increase your payment frequency to weekly
This will make a slight difference if you don’t have a mortgage offset
6. Move all your savings into redraw
Any savings in the redraw facility can be accessed within 24 hours
They effectively earn the home loan’s rate of interest (tax free)
7. Be careful of too much in offset account
Keeping $100,000 in an offset account is the same as $100,000 in redraw
… but you will feel ‘richer’ every time you see your transaction balance
… and will end up spending a lot more!
8. Negotiate a good interest rate
Shop around, use a mortgage broker
… threaten to refinance with another bank!
9. Variable rates should be better over long-run
You are saving the ‘liquidity premium’
… and have a lot more flexibility to make additional repayments
… and refinance the home loan (lower rates)
10. Positive cash flow v negative gearing
Australians seem to be obsessed with paying less tax (negative gearing)
Negatively geared properties are usually negative cash flow
… although not always due to deprecation tax deductions not being a cash flow

Positive cash flow investments = less cash flow stress and happier life!
Your Financial Plan
What is your long-term strategy for property?
Will you focus on only your primary residence or investment properties too?
Perform some detailed research for your next property acquisition
What will be your ‘dwelling’ needs for each of your life stages
What will be your borrowing strategy for each life-stage?
What product features are attractive to you? Why?

More information under ‘Financial Plan Instructions’ document

… on the course website under ‘Financial Plan’ section
Join us in a Drop-in Session
This course adopts a Flipped Classroom approach to give you maximum flexibility
1. Lectures are pre-recorded and can be watched at any time
2. The lecture time for discussion and questions

Joining a drop-in session helps you feel part of a ‘Learning Community’

Attendance is encouraged … but not recorded or assessed

Details of the drop-in session are towards the top of the course website
If you can’t attend then you are welcome to ask questions on General Forums